Perpetual contracts are a type of futures contract, but with no expiry date.
All perpetual contracts have a crucial mechanism called funding rate that makes their working possible. This funding rate is supported by longs or shorts in the market that work together to keep the perpetual’s price closest to the underlying crypto’s spot rate. If understood and used well, ETH perpetual contracts offer traders an excellent profit and/or passive income opportunity.
In this article, we’ll learn about ETH funding rates, how and where to make money off them and the risks involved.
ETH Perpetuals And Funding Rates, Explained
A futures contract is an agreement between two traders to buy and sell an asset at a pre-agreed price on or before a future expiry date. In the cryptocurrency market, this pre-agreed price is the crypto’s spot price when opening the contract.
An important characteristic of a futures contract is that it’s a type of derivative contract, implying that it derives its value from the underlying asset. The two traders only exchange the price difference from the opening and settlement time, with no actual asset exchanging hands.
Perpetual contracts work much like futures but don’t have an expiry date. It means that you can keep a perp open indefinitely and close it whenever you want. Perpetuals are more popular than futures since they give traders the flexibility to close their positions anytime.
With perpetuals, traders can also earn a passive income in the form of a funding fee. The traders pay each other this fee depending on existing market conditions (bullish or bearish) and whether they’re long or short the perpetual contract.
ETH perpetual contracts are in great demand due to the token’s high market cap and price volatility, especially post ‘Ethereum Merge.’
What Are ETH Funding Rates?
Since ETH perpetual contracts don’t have an expiry date, exchanges need to keep their price close to the ETH spot rate. They do this with the help of a price anchoring mechanism called the ETH funding rate.
This funding rate is used in the calculation of ETH funding fees payable by longs/shorts to their counterparties. The funding rate is positive in a bull market and negative in a bear market. In general:
ETH funding fee = nominal value of position x funding rate
An ETH perpetual contract’s price fluctuates and deviates from the spot rate based on the market conditions. In a bull market, more people would buy ETH perps, driving its price up.
Thus, longs would pay a funding fee to the shorts, encouraging more shorts to enter the market and pull down ETH perp’s price closer to ETH spot rate. The opposite happens in a bear market.
The funding fee is calculated and paid periodically, with time intervals varying from exchange to exchange. On most exchanges, it’s paid on an hourly, 4-hourly or 8-hourly basis.
Positive And Negative ETH Funding Rates
A Positive ETH Funding Rate Means
- Traders who are long have to pay a funding fee to traders who are short.
- It’s a bull market, with ETH perpetuals trading at a price higher than ETH spot price.
- You can hedge your ETH investments in the spot market by going short in perpetuals and also earn a funding fee.
A Negative ETH Funding Rate Means
- Traders who are short have to pay a funding fee to traders who are long.
- It’s a bear market, with ETH perpetuals trading at a price lower than ETH spot price.
How Do People Make Money Off ETH Funding Rates?
Arbitrage is a market-neutral trading strategy that helps you profit from different ETH funding rates on two different platforms. You open equal positions on both sides of the trade in an attempt to make a profit on the difference between the two. Let’s understand this with an example.
Assume ETH funding rate is 0.009% on Exchange A and -0.003% on Exchange B, re-calculated and paid out hourly on both.
This means that on Exchange A, longs will pay shorts a funding fee at the next 1-hour interval, calculated at 0.009%. On the other hand, on Exchange B, shorts will pay a funding fee to longs at the next 1-hour interval, calculated at -0.003%.
Let’s assume you have $20,000 capital, and the funding rates remain unchanged for the next 24 hours.
If you open a short position with a $10,000 margin on Exchange A, you’ll be paid a funding fee by longs every hour, as long as your position stays open. Your daily profit potential without any leverage will be ($10,000 x 0.009%) x 24 = $21.6. With 5x and 10x leverage, that translates to $108 and $216 per day, respectively.
Similarly, opening a long position with a $10,000 margin on Exchange B, will earn you ($10,000 x 0.003%) x 24 = $7.2 per day (without leverage). Using 5x and 10x leverage will make you $36 and $72 per day, respectively.
Your total revenue per day, excluding exchange fees and without leverage, will be $21.6 + $7.2 = $28.8. It’ll be $144 and $288 daily, with 5x and 10x leverage, respectively.
However, please note ETH prices and funding rates keep fluctuating with changing market conditions. You’ll need to monitor them on both exchanges actively. Therefore, this can’t be termed as a ‘set it, forget it’ strategy.
Cash and Carry
The cash-and-carry strategy helps exploit discrepancies between an asset’s spot and perpetual contract price.
Assume you have $2,220 capital, and ETH is currently trading at $2,000 in spot but at $2,200 in perpetuals.
You buy 1 ETH for $2,000 in spot and simultaneously open a short position with $2,200 margin in the perpetual futures market. Assuming that you availed 10x leverage and the hourly funding rate stays 0.009%, your daily profit potential would be ($2200 x 0.009%) x 24 = $4.75 (excluding exchange fees).
Why it’s called cash-and-carry is because traditionally, traders would ‘carry’ the asset in the spot market until the expiry of the futures contract. But since we’re dealing in perpetuals, you can carry the spot investment for as long as is feasible. Besides earning a funding fee, you can also book profit when the ETH prices in perpetual and spot markets converge.
However, unlike the funding fee arbitrage example (where both trades can be leveraged), your profit potential in cash-and-carry is limited by available capital for spot investment.
Historically, funding rates are found to reflect the general market sentiment around the underlying crypto asset.
For instance, if the ETH funding rate is highly negative, it implies a bearish market sentiment. In this scenario, most ETH traders are seen shorting the crypto, expecting its price to fall further in future. The vice versa is true for a highly positive ETH funding rate.
A higher funding rate, whether negative or positive, also suggests a higher deviation of the perpetual price from the spot rate. It is indicative of an overly optimistic or pessimistic market sentiment with a high probability of correction.
Where To Trade ETH Perpetual Contracts
|Exchange||Accepts US Customers?||Trading Pairs Offered For ETH||How Often Funding Rates Are Set||How Often Funding Rates Are Paid Out||Leverage Range For Perp Futures|
|Bybit||No||ETH-USDTETH-USDCETH-USD||8-hour intervals||8-hour intervals||Up to 100xUp to 66.67xUp to 100x|
|dYdX||No||ETH-USD||8-hour intervals||1-hour intervals||Up to 20x|
ETH perpetual trading pairs tell you which crypto/fiat assets you can use as margin to buy or sell the ETH perpetual contract. So, if it’s an ETH-USDT trading pair, you can deposit USDT tokens to open ETH long/short positions in the perpetuals market. On most platforms, ETH is paired with stablecoins like USDT, USDC, BUSD, or USD fiat for opening perpetual positions.
Different exchanges offer different trading pairs for ETH perpetuals. Below we’ve listed some well-known crypto exchanges and the ETH perpetual trading pairs supported by each:
Deciding which platform to use for ETH perpetual trades will depend on multiple factors, including your location, trading strategy, personal preferences and transaction fees.
Most exchanges don’t offer ETH perpetuals in the US and UK due to regulatory restrictions. The extent of leverage you prefer using in your trades would also determine your choice of trading platform.
The ETH perp funding rates may vary from exchange to exchange as well, thus providing profitable opportunities to arbitrageurs.
Bybit ETH Leverage And Margins
Bybit offers up to 100x leverage on perpetual trades. You’ll need to deposit an initial and maintenance margin of 1% and 0.5%, respectively, to open and maintain an ETH-USDT perpetual position of up to 900,000 USDT value.
For positions valued higher than that, the initial and maintenance margin percentages will increase in a tiered manner. Details on ETH-USDC and ETH-USD margins can be found on linked-to pages.
|Position Value In USDT||Max Leverage||Maintenance Margin Rate||Initial Margin Rate|
Leverage, Initial Margin and Maintenance Margin Table for ETH-USDT Perpetual. Source: Bybit
Like its peers, ByBit’s trading fee structure is also tier-based. Its trading fees for perpetual contracts range from 0% to 0.06%, depending on your user level. The funding fee is calculated and paid out every 8 hours, based on the following formulae:
Funding Fee = Position Value x Funding Rate
Position Value = Quantity of Contract / Mark Price
Funding Rate (F) = Premium Index (P) + Clamp (Interest Rate (I) – Premium Index (P), 0.05%, -0.05%)
dYdX ETH Leverage And Margins
dYdX is a decentralized crypto exchange (DEX) that allows you up to 20x leverage on perpetual trades. The initial and maintenance margin requirements begin at 5% and 3%, respectively, for ETH-USD perpetual trades. The initial margin requirement remains at 5% until the baseline position of 500 ETH. Thereafter, it increases linearly by 0.01 per 100 ETH.
|Underlying Asset||Baseline Position||Incremental Position||Max Position Size||Incremental Initial Margin Fraction|
The platform doesn’t charge any fee to users with the last 30-day trading volume below $100,000. Above that, the trading fee ranges from 0.05% to 0% based on 30-day volume. You can earn fee discounts of up to 50% if you hold dYdX’s Ethereum-based NFT assets called Hedgies.
dYdX pays out funding fees in USDC tokens on an hourly basis. However, its funding rate is calculated every 8 hours, as follows:
Funding Fee = Size of the Position (S) x Index price for the market supplied by Oracle (P) x Funding Rate (R)
Funding Rate = (Premium Component / 8) + Interest Rate Component
Final Thoughts On ETH Funding Rates
Funding rates can seem a bit complex to people new to perpetual trades. We have done our best to simplify them and make them understandable even for absolute beginners. Simply put, funding rates are a mechanism through which the price of ETH perpetual contracts is kept closest possible to the ETH spot rate.
This is necessary because perpetual contracts never expire, and their opening and closing prices must reflect the prevailing market price. We discussed how to profit from funding rates and some popular exchanges you can use for that purpose.
Frequently Asked Questions
Different exchanges have different methods of calculating ETH funding rates. They are derived from two important factors – premium component and interest rate. The premium component quantifies the perpetual price’s deviation from the spot rate, and the interest rate is a constant percentage.
The earnings from ETH funding rates may incur ETH funding rates taxes in some countries. You should refer to crypto tax laws in your state or country to learn more about this.
The ETH funding rates are paid by traders to each other. If the ETH funding rate is positive, longs pay shorts, and if it’s negative, shorts pay longs.
ETH perpetual futures work by connecting buyers and sellers willing to speculate on ETH’s future price movements. Since the prices of ETH perpetual contracts are tied to the ETH spot price through funding rate, they can be speculated on without any actual exchange of ETH.
The price of ETH, like that of all cryptocurrencies, is highly volatile in nature. Any abrupt movements against your position can cause you huge losses, especially if it’s leveraged.
No. The crypto regulations in the United States prevent exchange platforms from offering ETH perpetual contracts in the country.